Why Is Gas So Cheap Right Now?

Despite it's being the middle of the summer driving season, gas prices have fallen in recent months. Why is that? And at what price does gas have to be to make Americans demand more fuel-efficient cars? Vote below!

In the week running up to the July 4th weekend, the average price of a regular gallon of gas is $2.75. The cost of fuel has been on a steady downward slope since May, when the average price was nearly three bucks a gallon. And if we adjust the price of fuel for inflation, the cost of gas is as cheap as it was five years ago. Compared to the summer of 2008, when the price spiked to $4.05 a gallon and pundits everywhere warned that the future would hold higher prices, today's scenario is a bit unexpected. So what gives?

First of all, a word of warning. We're not professional speculators or financial wizards, so before we take a crack at explaining what's going on, we would like to remind you what the CEO of Nissan-Renault, Carlos Ghosn, said as he introduced the all-electric Leaf in Tokyo in 2009: "History shows us that we are incapable of predicting the price of oil."

So with that caveat, let's begin with the oil-price bubble of two years ago. In 2008, the price of a barrel of oil ballooned 58 percent from January 2008 to the peak of $134 in July. The reasons for this price spike are unclear. Many economists believe that speculators, who were banking on increased oil demand from emerging markets like China and India, falsely created the spike. But still others, notably Paul Krugman from the New York Times, said that other economic data of the time, such as the high price of steel, suggested that speculators weren't the real cause. The high price was simply following demand.

It's impossible to know for sure, but not long after, another bubble burst—the housing bubble—and we all know the turmoil that followed. Gas prices dropped like a lead balloon, falling to below $2 by December 2008, the lowest in over a decade.

Over time, the price has crept back up as the world's economies slowly sputtered back to life.

But since May, the price is down roughly 6 percent. This time the drop-off is a little tougher to unravel. For sure, economic output is not as robust, perhaps, to sustain a cost increase. But there's another factor that's more complicated than what we learned in conomics 101. It has to do with the relative value of the world's currencies, specifically, the euro versus the dollar. The euro is tied to a host of European nations and, as you have probably heard, some of those countries are in a bit of a debt crisis, and that has led to the value of the euro falling in relation to the dollar. Crude-oil prices are tied to the dollar so, in simple terms, our stronger currency is simply buying more oil than before.

That's where we are today, but what does the future hold? If we knew, of course, we'd be at a desk trading oil futures and well on our way to an early, very comfortable retirement. But from the folks we've talked to, it seems safe to say that gas prices should remain relatively steady over the summer driving season.

After that, most carmakers and economists believe the price has nowhere to go but up, which will increase demand for fuel-efficient cars. That's one reason we're seeing a steady influx of new, attractive small cars like the Ford Fiesta, the Chevy Cruze, and the Nissan Juke, among others.

Somewhere in the graph of gas prices is a point where consumers will dramatically shift their car-buying habits. We saw it in 2008. When the price of a gallon cleared $3.50, suddenly pickups sat on the lots and Honda Civics breezed off showroom floors.

But still, that price is just a guess that could use some more data. So help us out and vote. At what price do you think U.S. car buyers will finally start clamoring for even more fuel-efficient little cars like the small diesel-powered units already sold in Europe? Or what about the vehicles sold overseas that are even smaller than the Ford Fiesta—the cleverly-packaged Toyota IQ, the Audi A1, or the VW Polo? Is there a price at which those cars would be in high enough demand to warrant bringing them over?

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